Monetary and Financial Instability and European Bank Interest Margins

Abstract

This paper studies the extent to which financial instability and monetary and exchange rate policy influence European bank net interest margins, controlling for microeconomic variables and allowing for the heterogeneity of the banking industry. The sample is a broad cross-section of balance sheet and income statement information provided by banks from 12 European countries.

We conclude that European banks are sensitive to exchange rate and interest rate volatility. They are also affected by their home country’s vulnerability to balance of payment and currency crises, but we find that banks feel differently about the associated risk of liquidity problems depending on their specialization. The instability of international financial markets is not good for banks, insofar as interest and exchange rate volatility both have a negative impact on the net interest margin.